Did Microsoft overpay for LinkedIn?

Microsoft Corp. paid a whopping $26.2 billion in cash — a 50% premium — for LinkedIn Corp. in what some analysts call an overpayment and others say might make Microsoft an indispensable force in a modern corporate world similar to the way Windows did in the 1990s.

The deal, Microsoft’s
MSFT, +1.76%
biggest ever, represents a major move for CEO Satya Nadella, who took the reins in February 2014. (The company bought Skype in 2011 for $8.5 billion.)

“This is about the next phase of growth for Microsoft,” Nadella said Monday morning on CNBC.

But some analysts wonder whether Microsoft overpaid. This deal marks the sixth largest technology-industry acquisition ever, according to Dealogic.

Roger Kay, founder of tech consulting company Endpoint Technologies Associates, said he believes Microsoft might end up writing this down like it did with Nokia’s phone business. Microsoft bought the Nokia business for $7.2 billion in 2013, but admitted it made a mistake and wrote down the acquisition last summer for $7.6 billion.

The purchase price represents a multiple of roughly eight times LinkedIn’s
US:LNKD
sales.

Microsoft “has never done well with large M&A,” said UBS analyst Brent Thill in a note to clients. Microsoft wrote down its $6.3 billion aQuantive deal in July 2012.

“We believe Microsoft may have overpaid for a decelerating business with negative GAAP margins,” said Macquarie Research analyst Sarah Hindlian, in a note to clients.

LinkedIn hasn’t been outperforming. Even with Monday’s rally, LinkedIn’s
US:LNKD
shares are down 10% on the year, unable to fully recover from a sharp selloff in February that was triggered by weak earnings guidance.

The deal represents a purchase price of $196 a share, which is 29% below LinkedIn’s all-time high of $276 reached on Feb. 26, 2015. Shares of LinkedIn skyrocketed 47% to $192.99 on Monday after the deal was announced, while Microsoft’s fell 1.8% to $50.55, pushing them down nearly 5% over the last three months.

However, some analysts say the acquisition might be worth the price when considering how it could modernize Microsoft’s enterprise software offerings. Monness Crespi Hardt analyst James Cakmak noted that the deal, while appearing large, is comparable in size to a year of Microsoft’s free cash flow and considerably smaller than the $105 billion in cash and short-term investments on its balance sheet.

Microsoft also has strong free cash flow, achieving $25 billion FCF in fiscal 2016, and around $100 billion in cash and cash equivalents.

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“On the surface, based on the income statement and balance sheet, the numbers look high for an acquisition,” Pat Moorhead, founder and principal analyst at Moor Insights & Strategy, said in an email. “Therefore, it’s important to see what it *could* be.”

LinkedIn’s results will be reported as part of Microsoft’s productivity and business processes segment, which includes its Office 365 enterprise cloud software. LinkedIn’s revenue of $861 million would be a large addition to the Microsoft unit, where sales grew a slower-than-expected 1% year-over-year to $6.5 million last quarter.

Nadella said that while the LinkedIn branding would remain intact, the service would be integrated with a number of Microsoft cloud businesses, including its customer relationship management software business Microsoft Dynamics, OneDrive, Skype and Office 365.

“I can envision a service where businesses more freely collaborate, leveraging online versions of Office 365, Skype for business and OneDrive,” said Moorhead. “LinkedIn becomes more of a collaboration service,” which might help it compete with up-and-coming services, such as Slack.

Cakmak said LinkedIn’s addition will help Microsoft become indispensable among enterprise clients, enabling it to “create more dependency and stickiness in the business,” similar to the way Windows became the standard in the late 1990s.

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“We believe the strategic rationale makes sense,” said Citi analyst Mark May in a note to clients. “LinkedIn has, for some time, been the ‘Outlook address book’ for most business professionals. There are likely new ways MSFT can integrate / extend this franchise by owning it.”

Stifel analyst Brad Reback said he believes Microsoft paid a “fair price for a unique asset that would be very difficult to replicate organically.” He thinks the deal would create several new ways for Microsoft to make money and justify the transaction cost over time.

The combination of Dynamics and LinkedIn might have been of particular interest for Microsoft, said Kay. When a call to a salesperson comes through from someone with a LinkedIn profile, for example, a window might automatically pop up with the profile so the person assisting the client can see details about the person they’re speaking to on the other end.

“Think of this as the beginning of a huge effort to start direct conversations with the people actually making the technology decisions in companies today and a stronger response to the threats Amazon, Apple
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and Google
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represent in business,” he said.

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